TPG's Bid For Par Reflects More Difficult Generic Environment

While the seemingly endless M&A process among generic drug companies means that the acquisition of Par Pharmaceuticals (PRX) isn't a complete surprise, it's an interesting deal all the same. Not only does this deal point to the cost of not having a truly global business, but it also seems to speak to the extent to which this sector could see pipeline-driven valuation worries in the coming years.

A Below-Market Bid For A Real Company

Par was a shrimp in comparison to Teva (TEVA), Watson (WPI), and Mylan (MYL), but still a real player in the U.S. generic drug space. Unfortunately, Par was not especially diversified across its product line, as key products like generic forms of Novartis' (NVS) Toprol-XL, AstraZeneca's (AZN) Entocort, Reliant's Rythmol, and Teva's Provigil were slated to comprise nearly half of the company's revenue this year.

Worse still, the company's near-term pipeline was not especially promising. When the company lost in court to GlaxoSmithKline (GSK) over generic Lovaza and removed generic Asacol from its pipeline, a lot of the near-term hope evaporated.

Although Par's long-term pipeline and R&D capabilities look very good, the Street is not paying much for potential in the generics space. Consequently, TPG's $50 cash offer for Par represented a 37% premium on the shares, despite the fact that the offer is basically just in-line with current industry multiples (whereas most deals are done at a premium).

Will Anyone Else Step Up?

As is commonplace today, TPG gave Par's board a roughly one-month go-shop period to solicit a better bid. At this point, I'd say there's a slim (but not zero) chance that another company comes with a bid.

Based on the multiples recently paid by companies like Novartis, Watson, and Valeant (VRX), there would seem to be at least 10-20% upside to a rival bid without challenging or exceeding recent multiples in generic M&A.

Unfortunately, Par doesn't offer what companies generally want today. Par will not give its buyer any particular international or emerging market exposure, it won't bring any special R&D focus or capabilities, and it won't bring any proprietary branded drugs of note. What it will bring is an arguably undervalued longer-term pipeline, but would investors in Teva, Watson, or Mylan really reward what would basically be a value-oriented acquisition? Current market conditions suggest that the answer is "no".

The Ongoing Challenges For Generics

Whenever articles appear talking about the strongest long-term trends in healthcare, generic drug companies like Teva often feature prominently. That's with some good reason, as the generics industry is enormous and people continue to need and use pharmaceuticals at a growing rate.

There's a fly in this ointment, though. With the expiration of patents covering many blockbuster drugs over the past few years, the near-term golden age for generics companies has come and gone. Simply put, there just aren't nearly as many major drugs going off patent over the next three to five years.

The reason that really matters is an often under-appreciated detail of the generics business - the above-average profits that go with being the first to file and challenge a patient. When a new generic drug comes out and is granted that window of exclusivity, it is often priced at 50% or more of the branded drug. Though that window of abnormal profitability is brief (other generics eventually enter and push the price down, sometimes to 10% of the original or less), and it's true that companies like Teva can enjoy a decade or more of sales and profits from a generic drug, that exclusivity is a real sweetener.

Now it's true that some patent expirations expected in the 2011-2013 timeframe have been pushed out, and it's also true that biosimilars (generic competition for biological drugs like Abbott's (ABT) Humira) could be a sizable opportunity. Nevertheless, the market isn't as sweet as it once was, and the ability and opportunity to sell into growing emerging markets like China and Brazil, as well as invest the resources into expensive biosimilar development, are likely to be major competitive differentiators over the next few years.

The Bottom Line

Kudos to TPG for seeing the long-term value in Par and being willing to step up with a bid. Likewise, although I wouldn't be stunned to see a rival bid, I don't expect one.

I do wonder, though, what this says for smaller players like Impax (IPXL), Hi-Tech Pharmacal (HITK), and so on. Simply put, this could be a case where those companies who aren't able to drive a stake in the ground and build around a defensible or valuable niche (or exploit overseas growth) risk getting left behind by investors. At the same time, with Mylan and Watson trading near 52-week highs and valuation looking less demanding, Teva could be a name well-worth considering given its huge global generics business and arguably underappreciated branded drug business.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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